Inflation tame, but Fed may still trim bond buying

Consumers purchase gasoline at a gas station as a plane approaches to land at the airport in San Diego, California October 8, 2012. REUTERS/Mike Blake

By Lucia Mutikani

WASHINGTON (Reuters) - Consumer prices were flat in November, but the lack of inflation pressures in the economy will probably not stop the Federal Reserve from scaling back its bond-buying program soon.

The Labor Department said on Tuesday its Consumer Price Index was restrained last month by declines in gasoline and natural gas prices. It had slipped 0.1 percent in October.

The low inflation environment comes against the backdrop of an improving economic outlook, which economists say will embolden the U.S. central bank to take a step towards normalizing monetary policy at least by March.

"If the Fed wanted an excuse to continue with the full bond purchases they could use the inflation numbers," said Gus Faucher, a senior economist at PNC Financial Services in Pittsburgh. "But given the strength in we have seen in the labor market and in other economic indicators, I think they do want to reduce their purchases."

The inflation report was released as Fed officials prepared to start a two-day policy meeting. The central bank will weigh an array of data from employment and retail sales to industrial production that have suggested the economy is on an upswing.

A separate report on Tuesday that showed confidence among homebuilders increased in December bolstered that view. It suggested housing will continue to lend support to the economy despite higher mortgage rates.

Some economists expect the Fed to announce a reduction in its $85 billion monthly bond buying program at the end of its meeting on Wednesday, although more believe it will wait until January or March.

When it does move, persistently low inflation would likely lead it to act cautiously before beginning to raise overnight interest rates, which have been held near zero since late-2008.

"Even after the Fed starts to reduce its bond purchases, policy will be extraordinarily easy," said Jay Morelock, an economist at FTN Financial in New York.

HOUSING SHOWS SOME INFLATION

U.S. financial markets were little moved by the data as investors awaited the outcome of the Fed meeting.

In the 12 months through November, the CPI rose 1.2 percent. It had increased 1.0 percent in October, the smallest advance since October 2009.

Stripping out the volatile energy and food components, the so-called core CPI rose 0.2 percent after rising by 0.1 percent for three consecutive months.

That left its increase over the past 12 months at 1.7 percent, where it has now been for three straight months.

The Fed targets 2 percent inflation, although it tracks a gauge that tends to run a bit below the CPI.

A 1.6 percent drop in gasoline prices and a 1.8 percent fall in the cost of natural gas last month offset increases in electricity, keeping inflation subdued.

Food prices rose marginally.

Tame inflation is giving consumer purchasing power a lift. Adjusted for inflation, average hourly earnings increased 0.2 percent in November after edging up 0.1 percent the prior month.

Within the core CPI, apparel prices fell for a third straight month, reflecting discounts offered by retailers to lure shoppers and reduce inventory.

There were, however, gains in rent. Owners' equivalent rent of residences, or OER, which accounts for about a third of the CPI, posted its biggest monthly gain in five years, and was up 2.4 percent from a year ago. It was the biggest year-on-year gain since September 2008.

"We remain of the view that OER, and shelter costs more generally, will continue to be the main driver of core inflation during 2014," said Peter Newland, a senior economist at Barclays in New York.

Medical care costs were flat, while prices for new vehicles fell for a second straight month.

(Reporting by Lucia Mutikani; Additional reporting by Richard Leong in New York; Editing by Andrea Ricci)